Academic journal article Economia

Firm Dynamics and Productivity: TFPQ, TFPR, and Demand-Side Factors

Academic journal article Economia

Firm Dynamics and Productivity: TFPQ, TFPR, and Demand-Side Factors

Article excerpt

(ProQuest: ... denotes formulae omitted.)

The development of rich longitudinal business databases for many countries in the last few decades has generated new core facts about the joint distributions of firm-level productivity, firm size, and the pace of the reallocation of outputs and inputs across firms.1 First, there is tremendous dispersion in productivity across firms in the same industry. Second, there is tremendous dispersion and skewness in the size distribution of firms across firms in the same industry. Third, there is a high pace of the reallocation of outputs and inputs across firms within industries. Fourth, firm entry and exit contribute substantially to the pace of reallocation. The recent evidence suggests that these patterns hold widely in both advanced and emerging economies.

Economic theory and accumulating empirical evidence show that these facts are related in ways that vary systematically across countries. Allocative efficiency implies that the more productive firms should be larger or becoming larger, while less productive firms should be smaller or becoming smaller. These patterns relating size and growth to productivity seem to hold to a greater extent in advanced economies than in emerging economies. This has led to the working hypothesis that the large observed differences in gross domestic product (GDP) per capita across countries are driven by distortions to these allocation dynamics within countries. This has, in turn, yielded a growing literature that seeks to identify the distortions generating misallocation.2 Progress has been made, but there is still much to be done to identify the most relevant distortions in specific countries, industries, and time periods.

One complicating factor in terms of both theory and evidence is that the observed dispersion in productivity across firms is not time invariant. Idiosyncratic productivity differences are persistent, but not permanent.3 This has led to a richer characterization of firm dynamics: in well-functioning economies, firms with positive idiosyncratic shocks will endogenously innovate successfully or successfully adapt to a changing economic environment, resulting in the growth of the firm, while firms with adverse shocks will fail to innovate or adapt and thus will shrink and exit. This implies that the nature and consequences of distortions may be affecting the dynamic aspects of the reallocation process. Differences across countries may show up in the extent to which businesses with positive innovations in productivity grow, while businesses with negative innovations in productivity contract.

While there are many open questions in this expanding literature, I focus on two related areas of inquiry that reflect the interaction between economic theory and economic measurement. The first area of inquiry aims to identify the most appropriate measure of firm performance when studying the evolution of firms. The second explores the role of demand-side factors in firm dynamics. An understanding of these two issues is critical to keep important concepts from becoming muddled.

The first area of inquiry stems from the emphasis in the literature on firmlevel productivity as the measure of interest. However, most firm-level databases do not permit measuring firm-level prices, so the most commonly used empirical measures of productivity are revenue-based measures.4 The key measurement issue is that firm-level real output is measured as firm nominal revenue divided by an industry-level price deflator. This implies that firmspecific price variation is captured in measures of firm-level productivity. Thus, the typical empirical measure used differs from the theoretical concept of productivity, which reflects output per unit of composite input, taking into account the production technology relating inputs to output. This measurement issue has potentially important theoretical implications: since firm-level prices are likely endogenous, these alternative measures may have quite different properties. …

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